Helping foreign real estate investors is not Indian Prime Minister Narendra Modi's top priority, especially when he is preparing for the parliamentary election due next year.
But even though his policies are now focused on poorer voters -- especially on people living in India's myriad villages -- his government has presided over the sort of sustained economic growth that attracts property investors and pushed through reforms that have considerably benefited the sector.
Private equity and debt investments in India's real estate in the year 2017 grew 12% year-on-year to $4.18 billion across 79 transactions compared with $3.73 billion across 138 deals in 2016.
To name two examples, Singapore's sovereign wealth fund GIC acquired a stake in India's DLF Cyber City for 1.9 billion Singapore dollars (US$1.45 billion) in August; meanwhile Canadian Pension Plan Investment Board invested $500 million into industrial real estate developer, IndoSpace, in May.
We should similar inflows and more such deals going forward. Our research posits that private equity inflow in real estate will grow at 10% annually for the next ten years, with big and medium-sized cities being the main beneficiaries. But in order to maintain the momentum, Modi needs to ensure the economy continues to expand and his commitments to reform do not wane.
As Modi said last month at the World Economic Forum in Davos last month, gross domestic product has risen more than sixfold since the last time an Indian prime minister attended in 1997. India, he predicted, would be a $5 trillion economy by 2025, compared to $2.2 trillion now, the seventh largest in the world in terms of nominal GDP.
Not surprisingly, investors are keen to make a strategic entry or increase their exposure in the country.
As Modi promised, India is "removing the red tape and laying out the red carpet." The shake-ups of the last two years -- the November 2016 demonetization, the implementation of the real estate regulation act in May 2017, and the replacement of service tax with goods and services tax (GST) in July 2017 -- were the long overdue catalysts for this turnaround.
The real estate industry previously suffered from having a reputation as a repository for black money. The reforms have helped it improve its standing. For example, demonetisation, which involved the dramatic cancellation of high-denomination bank notes, has assisted in sucking undocumented cash flows, including wads of money in suitcases, out of the market. The new regulation act has helped improved transparency and protected property buyers' interests by ensuring that developers meet stipulated compliance standards and conditions, for example for accurate measurement of actual living space and quality of construction. Meanwhile, the GST simplifies the multiple taxation system previously that included VAT and service tax that varied from state to state.
In a further signal to investors, the national government recently approved 100% foreign direct investment in real estate broking services and construction to promote ease of doing business and attract more global investors. This, in turn, would help create a real estate market with best practices, better auditing and reporting processes
With these developments unfolding, we foresee India will continue to be a top emerging market for investors, with its top-quality office and retail sectors projected to show the highest total returns this year -- 8 to 9% for prime office yields and 9 to 10% for prime retail yields.
The cities of Pune, Bangalore and Chennai surpassed their pre-financial crisis office rental peaks of 2008, recording 10.1%, 14.3% and 5.6% rental growth respectively in the last two years combined. Hyderabad is set to follow suit in 2018; the office corridors of Bangalore, Gurgaon (near New Delhi), Hyderabad and Pune are expected to see further rent appreciation in 2018, in the range of 6 to 8% year-on-year while suburbs and secondary business districts in Mumbai and Chennai should also see similar gains.
Pent-up demand from large corporations which earlier delayed taking up office space due to instability from the reforms will take the lead in occupying new space. So will the growth of co-working in India. Our studies shows that the potential co-working market size in India is currently in the range of 12 to 16 million workers, and total space leased by co-working operators in the top cities could potentially stand at seven to 9 million sq. feet out of a total Grade A market of 600 million sq. feet in 2020. In 2018 alone, India is projected to receive $400 million in investment in co-working spaces.
With a growing middle-class and greater consumption, India's retail sector is looking solid with the private equity set. The Blackstone Group's India subsidiary Nexus Mall expanded its footprint with the purchase of Elante Mall in the northern city of Chandigarh last year and recently took a 75% stake in Esplanade Mall in Bhubaneswar in eastern India for $39 million. The newly liberalized FDI ruling for retail has further attracted foreign companies such as Abu Dhabi-based LuLu group, which announced it is investing in shopping malls as well as a convention center and a hotel in India up to 2020.
However, India's residential sector, where first-time buyers are used to taking out loans, is still trying to find its footing after the reforms. Prices have been stagnant for last three years while prices in the national capital region have dropped as home sales decreased and demand softened. Small developers bore the brunt of the reforms. They found it hard to manage a rise in financing and compliance costs after demonetisation reduced liquidity, ending up highly leveraged after accumulating too much land.
Restructuring and consolidation are likely to take place in the form of smaller developers entering joint ventures, joint developments or development management partnerships with larger groups, which see value in securing land at strategic locations, that smaller local players have access to, for their future pipeline.
The national budget announcement last month fell short for many in the residential sector as there were no changes in income tax or favorable measures introduced such as assigning industry status to real estate. However, opportunities could present themselves in other government initiatives. Take the Smart City Mission, an urban renewal and retrofitting program that aims to transform India's urban ecosystem, which real estate players should actively participate.
In addition, the establishment of an affordable housing fund under the National Housing Bank for priority sector lending could give a further impetus to the development of housing. but it might prove challenging for various state and local governments to expedite the traditionally protracted and complex processes of granting building permissions for developers.
There are also other potential problems such as construction companies not being able to scale up to cope up with the demand for affordable housing; and supporting infrastructure proving insufficient to support this spurt of urban growth. Last year's tragic flood in Mumbai underscores how the commercial capital of India is struggling with lack of proper drainage and poorly maintained building while 63% of urban sewage is simply untreated and flowing into rivers, according to India's Central Pollution Control Board.
These are crucial issues to tackle even as the different sectors in India's diverse real estate landscape continue to evolve at different speeds. But with business sentiment and transparency improving, many investors see this is a good time to bet on India.
Anthony Couse is the Asia Pacific CEO at JLL.